DBRS, Inc. (DBRS Morningstar) confirmed the Swiss Confederation’s Long-Term Foreign and Local Currency – Issuer Ratings at AAA. At the same time, DBRS Morningstar confirmed the Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (high). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The confirmation of the Stable trend reflects DBRS Morningstar’s view that Switzerland’s credit fundamentals remain solid and resilient, despite the economic shock from the Coronavirus Disease (COVID-19). Switzerland’s economy has recovered rapidly from the pandemic shock, with growth estimated at 3.5% in 2021 after a relatively modest contraction of -2.4% in 2020. Growth has been supported by a strong fiscal response, a competitive export sector, strong household balance sheets, and expansionary monetary policy. Although the swift and sizeable government support measures to the economy resulted in a deterioration in the deficit to 2.6% in 2020, Swiss public finances have been disciplined and anchored by the debt brake rule, and thus the pandemic-related increase in deficits is likely to remain cyclical and short lived. The IMF expects a near balanced fiscal position of -0.3% in 2022 and -0.1% in 2023. Moreover, Switzerland continues to have one of the lowest debt ratios among sovereigns in the AAA category (40.9% of GDP in 2021). Coupled with exceptionally low funding costs, this provides the government ample fiscal headroom to confront future shocks without compromising fiscal sustainability.
Switzerland’s AAA ratings are underpinned by its wealthy and diversified economy, sound public finances, and solid external position. Strong institutions, predictable policies, and historical neutrality have long made Switzerland a safe haven for investors. Switzerland benefits from a highly productive workforce, high levels of educational attainment and labor force participation. These credit strengths counterbalance the challenges associated with low domestic interest rates and the consequent search for yield that are fueling increased borrowing by domestic investors in the real estate market, thereby moderately increasing risks to financial stability. Additionally, the decision not to sign the institutional framework agreement with the EU could gradually lead to increased barriers to trade between Switzerland and the EU. That said, Switzerland is expected to provide appropriate responses to these challenges, and is firmly placed in the AAA category.
DBRS Morningstar considers the likelihood of a downgrade of Switzerland’s ratings to be low. Nonetheless, the ratings could be downgraded if severe external shocks or a sustained deterioration in growth prospects materially affect Switzerland’s financial stability and fiscal position.
Strong Swiss Fundamentals Support Ongoing Economic Recovery
The post pandemic economic recovery which started in Q3 2020 gained momentum in 2021 with gross domestic product (GDP) in Q3 2021 rising by 6.8% QoQ (annualized), already above its pre-crisis level led by consumption and foreign trade. The ongoing recovery in economic activity was also reflected in the labor market with the seasonally adjusted unemployment rate published by SECO coming in at 2.4% in December 2021, marginally above its pre-crisis level of 2.3% in February 2020. Further, the rebound in economic activity resulted in the output gap narrowing to -0.5% in Q3 2021. Swiss business sentiment remains positive with companies expecting the business situation to improve further over the course of the next six months. Consequently, following the -2.4% YoY pandemic driven contraction in 2020 growth, the Swiss economy is expected to have grown 3.5% in 2021 (3.3% adjusted for sporting events). While growth could see a few headwinds in the near term primarily due to rising cases of the Omicron variant, similar to most advanced economies due to high levels of vaccination and relatively fewer restrictions, disruptions to economic activity are likely to be modest relative to the previous Delta outbreak. The Swiss Federal Government’s Expert group on economic forecasts projects growth of 3.0% in 2022 and 2.0% in 2023 (adjusted for sport effects).
While the global and Swiss economic outlook still remains subject to high uncertainty due to the evolution of the virus, Switzerland’s ratings are underpinned by its wealthy and diversified economy, and its medium-term economic outlook remains strong. GDP per capita currently stands at USD 82,341 and its global competitiveness ranking is consistently one of the highest in Europe. This reflects Switzerland’s highly productive workforce, which is characterized by high levels of educational attainment and nearly 80% labor force participation. While the Swiss economy continues to outperform that of the Euro Area due to sustained consumption and investment growth, it faces several challenges in the medium to long term. As a safe haven currency, the Swiss franc remains vulnerable to appreciation pressures arising from risk aversion. Additionally, the decision not to sign the institutional framework agreement with the EU could increase trade barriers with its EU partners and may eventually have an effect on the attractiveness of Switzerland as a business destination.
Switzerland’s Low Public Debt Ratio and Solid Fiscal Framework Underpin its Creditworthiness
Switzerland’s sound fiscal position and solid fiscal framework has provided the country ample fiscal space to respond to the coronavirus pandemic shock without affecting its AAA ratings. Following five consecutive years of fiscal surpluses averaging approximately 1% of GDP, Switzerland posted a deficit of 2.8% in 2020 and around 1.7% in 2021 after implementing a fiscal package to support the economy. Swiss public finances have been disciplined, particularly since the introduction of the debt brake rule, and thus the pandemic-related increase in deficits is likely to remain cyclical and short-lived. The debt brake is designed to prevent the occurrence of recurring deficits as it ensures that expenditures and receipts are balanced over the business cycle in the federal budget, The IMF expects a near balanced fiscal position of -0.3% in 2022 and -0.1% in 2023.
While the deficit in 2020 and 2021 was partly financed by the government’s liquidity reserves, the contraction in growth resulted in the general government gross debt ratio rising from 39.8% in 2019 to 42.4% of GDP in 2020 before declining to 40.9% in 2021. The Maastricht debt ratio, which excludes pensions and healthcare, rose from 25.9% in 2019 to 27.8% of GDP in 2020 and started its decline to 27.0% in 2021, where it is expected to stabilize at marginally lower levels. Despite this increase, Switzerland’s public debt levels are low. Combined with substantial financial flexibility, these considerations help the country to stand out among other highly-rated sovereigns. The government’s debt maturity structure remains favorable, with average maturity of marketable debt (bonds and T-bills) at 10.2 years. All debt has been issued in Swiss francs. Currently, all marketable debt of the Swiss government has a negative yield to maturity. Interest expenditures for the general government, as estimated by the IMF, were less than 0.2% of GDP in 2020. Consequently, DBRS Morningstar does not expect the current macroeconomic and fiscal shocks to exert downward pressure on the country’s ratings.
The Swiss National Bank (SNB) Maintains Its Accommodative Stance; Major Banks Are Well Capitalized
Since the pandemic, the Swiss National Bank has maintained its highly accommodative stance to provide ongoing support to the Swiss economy, while ensuring price stability, which is defined as an inflation between 0%-2%. As a safe haven currency, the Swiss franc tends to attract inflows during global risk-off periods or when financial volatility increases. In light of the appreciation pressure on the Swiss franc, the SNB has kept its policy rate and interest on sight deposits at the SNB at -0.75% and continued its policy of unsterilized FX intervention. As a result, foreign exchange reserves touched a high of USD 1.1 trillion in December 2021. Similar to trends worldwide, headline inflation prints in 2021 were higher due to higher oil prices and supply-side bottlenecks, nevertheless, inflation in Switzerland remains significantly below that of other developed economies. The SNB’s new conditional inflation forecast stands at 0.6% for 2021, 1.0% for 2022, and 0.6% for 2023. However, the long-term inflation expectations are well anchored at around 1%, and have remained stable despite the pandemic.
Switzerland’s highly open economy and historical status as a financial center are important sources of growth and prosperity for the country but can also leave Switzerland exposed to external shocks as the size of the banking sector is nearly 500% of GDP. Similar to banks worldwide, Switzerland’s two global systemically important banks – Credit Suisse and UBS – benefited from the favorable macro environment with increased client activity and assets under management, leading to higher fee and commission income at both institutions. Moreover, the capital position at both banks increased further in 2021 with retained earnings leading to the increase at UBS, and the capital increase conducted in the wake of the losses relating to Archegos at Credit Suisse.
As regards domestic banks, overall profitability remains stable but low due to narrowing interest rate margins. Risks to financial stability remain as domestic banks’ exposure to mortgage and residential real estate markets have increased further. With mortgage growth outpacing income growth, Switzerland’s mortgage-to-GDP ratio has been gradually rising from 135% of GDP in Q1 2015 to 156% of GDP in Q1 2021. However, SNB’s scenario analysis indicates that most domestic banks have adequate capital buffers and would be in a position to absorb losses under relevant stress scenarios, including that of a large interest rate rise with a simultaneous correction in real estate prices. Furthermore, SNB continues to monitor mortgage and real estate markets developments closely, and regularly assesses the need for a reactivation of the countercyclical capital buffer. The SNB’s ongoing vigilance and proactive measures, have so far averted a rise in credit risks and have resulted in an upward adjustment in the “Monetary Policy and Financial Stability” Building Block Assessment.
Persistent Current Account Surpluses and Net Creditor Position Reflect Switzerland’s Strong External Accounts
Switzerland’s external accounts are characterized by a structural current account surplus and a positive net creditor position, and remain a key source of strength. The size and composition of its external accounts reflect its role as a financial center, an attractive location for corporations, and Switzerland’s high per-capita prime saver population. Switzerland’s persistent current account surpluses averaging 10% of GDP over the last two decades are increasingly driven by its trade balance and profits from merchanting.
Switzerland’s positive net international investment position of 115% of GDP in Q3 2021 reflects the substantial accumulated wealth of Swiss residents and official foreign exchange reserves. Much of the recent growth in gross external assets has stemmed from the SNB’s accumulation of official foreign exchange reserves. Over the last decade, the Swiss National Bank accumulated nearly CHF 700 billion. The SNB is responsible for managing the currency reserves that are currently allocated in an 80:20 ratio between bonds and equities. Due to its foreign exchange intervention, the SNB’s balance sheet stands at 143% of GDP as of September 2021, relative to the US Federal Reserve at 36.4% of GDP, the European Central Bank is at 69.1%, and the Bank of Japan at 134% of GDP. However, unlike the G3 central banks, the increase in SNB assets was primarily due to purchases of foreign rather than domestic assets.
Relations With the EU Hit a Roadblock But Strong Swiss Institutions and Stable Politics Are Likely to Limit Any Fallout
Switzerland’s political environment is characterized by its federal democratic system, high institutional capacity and low level of corruption. Stable politics combined with neutrality in international conflicts have long made Switzerland a safe haven for investors. The Federal Council, Switzerland’s executive body, is made up of seven members, each of which heads a government department. Decisions are made jointly. Combined with a bicameral legislature and multiparty system, political decisions require a broad degree of consensus. The system is highly deliberative and allows for frequent popular referenda on important issues. Thus far however, Swiss voters have displayed pragmatism by rejecting some of the most radical policy proposals. Furthermore, Switzerland has found ways to implement the results of some potentially problematic popular initiatives while preserving sound policies and meeting key international commitments.
Swiss-EU relations remain uncertain after the Swiss Federal Council called off discussions to streamline market access agreements last year due to substantial disagreements mainly on the Citizen’s Rights Directives and wage protection. (See Swiss-EU Relations At An Impasse). Switzerland is not part of the EU and its unique relationship is based on around 20 main agreements (amongst them two packages known as Bilaterals I & II) and several other agreements ensuring, among other things, access to the EU’s single market for several sectors. While the failure of talks could ultimately cause existing bilateral agreements to lapse resulting in higher administrative costs and over the long run erode the attractiveness of Switzerland as a business destination, DBRS Morningstar expects the Swiss to continue to operate harmoniously with their EU counterparts in the foreseeable future. Switzerland's European policy goals are focused on remaining a reliable and committed partner of the EU, a position recently reaffirmed by newly-elected President Ignazio Cassis. On November 24, the Federal Council approved a Memorandum of Understanding with the EU, reiterating its intention to expedite implementation of the second Swiss contribution of CHF1.3 billion towards cooperation programs with selected EU Member States, sending a positive signal to the EU that Switzerland seeks to continue the bilateral approach.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/391066.
All figures are in CHF unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).
Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.
The primary sources of information used for this rating include the sources of information used for this rating include the Federal Council, State Secretariat of Economic Affairs (Economic Forecasts), Federal Department of Finance (Budget 2022), Swiss National Bank (Quarterly Bulletin December 2021, Financial Stability Report 2021, Monetary Policy Statement December 2021); Federal Department of Foreign Affairs, European Central Bank (ECB), Eurostat, OECD, IMF (WEO October 2021), World Bank, BIS, Our World in Data, the Social Progress Imperative (2020 Social Progress Index), the 2019 and 2020 Global Competitiveness Reports from the World Economic Forum, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.
This rating was not initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is an unsolicited credit rating.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:
The last rating action on this issuer took place on July 23, 2021.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
Lead Analyst: Rohini Malkani, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Global Sovereign Ratings
Initial Rating Date: July 14, 2011
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